Should You Offer an Employee Stock Ownership or Profit-Sharing Plan?

When you’re building a business, having the right people on your team is critical. Being able to recruit rising stars and retain them necessitates providing incentives that keep your business competitive, including retirement plans, health insurance, and flexible work arrangements. Employee stock ownership plans and profit-sharing are also great ways to build loyalty among your employees — but is either a good fit for your business?

What is an employee stock ownership plan?

An employee stock ownership plan literally builds your employees’ investment in the success of your business. This method of incentivizing employees rewards them with stock in the company as part of their compensation packages, essentially making them part owners.

Investopedia contributor Akhilesh Ganti notes that an ESOP takes the form of a trust fund, which is used to purchase shares for employees. Typically, an employee is not granted stocks — they must make the decision to purchase them. That’s why this kind of plan is otherwise known as a stock option.

What is a deferred profit-sharing plan?

Another popular incentive to offer employees is a deferred profit-sharing plan. A DPSP is a kind of retirement plan in which, as Investopedia’s Will Kenton writes, contributions are made based on a percentage of your business’ quarterly or annual earnings. In essence, if your company earns a profit, a DPSP shares a portion of it with the employees who helped you earn it.

While this acts as a kind of retirement plan, Kenton notes that it’s unlike a 401(k) in that only the company can make contributions. What’s more, these contributions are discretionary — if there is no profit earned, there are no contributions made. The Internal Revenue Service also notes that a DPSP does not have to take the place of a traditional retirement plan, so you can offer it in conjunction with a 401(k) or IRA.

Why you may want to offer an ESOP or DPSP

The disadvantages of offering either an employee stock ownership plan or a deferred profit-sharing plan are largely monetary. As the IRS notes, these plans can carry higher administrative costs, and they will ultimately eat into the profits that your company earns.

However, if your company is in a position to earn profits, sharing it with employees is a good use of that cash. Offering an employee stock ownership plan, deferred profit-sharing plan, or even both plans gives you an advantage when you are looking to hire top talent. Especially if these perks are offered in conjunction with other retirement plans and health insurance.

Ganti also points out that ESOPs and DPSPs directly encourage employees to deliver top-quality results and hit their marks. Having a greater sense of stakes in the success of the company encourages employees to be more tapped in and motivated, aligning them with the business’s large-picture goals. Further, these plans will drive loyalty to the company and make it harder for competitors to poach your top contributors.

Employee stock ownership plans and deferred profit-sharing plans are great ways to attract great employees, spur hard work, and keep employees onboard as your company continues to grow. If you’re looking for ways to motivate your workforce and are in a position to share the wealth, consider either or both options.